Investing

Financial myths and realities: RRSPs and TFSAs

By Patricia Dubois

There are many money myths around, and Sun Life advisors have heard nearly all of them. Here are 2 about RRSPs and TFSAs – and the realities behind them.

There’s no shortage of misconceptions about money. Well-meaning but mistaken people spread them to family and friends and sometimes even try to convince their financial advisors. In this series of articles about financial myths and realities, we’re sharing some of what our advisors hear on the job, with the goal of separating fact from fiction. Today’s topic: RRSPs and TFSAs.

Myth #1: RRSPs are pointless – when you retire you’ll have to pay tax on withdrawals

“I sometimes have clients who think making registered retirement savings plan (RRSP) contributions is pointless because they’ll have to pay tax when they take the money out in retirement,” says mutual fund representative Nathalie Jacques.1 “This is both true and false.”

Keep in mind that contributing to an RRSP means you’re putting off paying tax on the money you contribute. So it makes sense to invest in an RRSP if you expect your marginal tax rate (the rate of tax you would pay on an additional dollar of taxable income) to be lower when you take your money out in retirement than it was when you put it in.

For example, if you live in Ontario and currently earn $68,000 per year, your marginal tax rate for 2017 is 29.65% (20.5% federal tax plus 9.15% provincial tax). If you contribute $1,000 to your RRSP, you'll get a 29.65% tax reduction, which works out to $296.50. But assume that when you withdraw this amount in retirement your taxable annual income will be lower – let's say $38,000. That makes your marginal tax rate 20.05% (15% federal tax plus 5.05% provincial tax), which means you’ll pay $200.50 in tax. You’ll end up ahead by the difference between the $296.50 you received and the $200.50 you paid: $96.00, and that’s on just a $1,000 contribution. So it’s really worth it!

On the other hand, your marginal tax rate if your income is $38,000 today and $22,000 in retirement will be the same: 20.05%. So it's 6 of 1, half a dozen of the other, making tax-free savings account (TFSA) contributions (which you make with money you’ve already paid tax on, so you don’t have to pay tax on withdrawals) an equally good solution.

And meanwhile, investment income in both RRSPs and TFSAs grows tax-free until you take it out, so why not own one? And if you can, why not own both?

Myth #2: TFSAs are just not worth it

“Contrary to what many people think, a TFSA can be just as profitable as an RRSP,” explains Jacques. Just as you do for an RRSP, you choose the type of investments to put in your TFSA, and that's what drives the return. It's not the type of account that matters, it’s what’s in the account.

“When TFSAs were first introduced, some financial institutions were promoting them as a place for their clients to invest in guaranteed interest certificates and term deposits, whose rates are pretty anemic, and that’s no doubt where this perception came from,” says Jacques. “But investors can, and even should, choose mutual funds, stocks and several other types of investments for their TFSAs.”

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